The Boeing bust of the early 1970s propelled lenders in the Seattle area into a crisis. Loan foreclosures left banks with collateral they really didn’t want. Instead of collecting payments every month, banks found themselves owning businesses and huge fleets of cars and boats – along with enough houses, hotels and property for a large-scale Monopoly game.
The experience changed banking, especially in this region. Seafirst Bank, then the largest in Washington state, became especially adept at disposing of forfeited property for maximum return – instead of simply dumping the stuff on the market, which had been common practice up until that time. The bank even found some people in its organization with the skills needed to run the businesses they were now stuck with.
What changed most fundamentally through the Boeing bust experience, though, was attitude. Banks in this area learned the value of “workouts” of troubled loans. Bank officers would sit down with home and business owners to try and figure out a way to get them back on their feet financially – and the loans eventually paid off. Despite the expertise the banks developed in dealing with forfeited collateral, they realized that workouts were more profitable than foreclosures.
Something similar is happening nationwide in today’s real estate market, which is suffering through a significant downturn. More than 1.1 million home mortgages were foreclosed last year, and this year doesn’t look any better.
Things change, of course, but lenders’ survival instincts are kicking in, just as they did for Seafirst (now Bank of America) decades ago. The players are different, since the bulk of the now troubled loans had originally been packaged up and sold to hedge funds and other investors. The language and terminology are different, too – workout specialists are now debt counselors, for example – but the goal is the same: find some way to keep the loan alive. Foreclosure is a loser’s game.
The reversal in the residential real estate market has been blamed on rising interest rates and on the deteriorating economy. Both explanations, however, are inadequate, and probably misleading.
There is no doubt that the U.S. economy has slowed down some – although exactly how much is still in question. The latest Commerce Department report shows a first-quarter annual growth rate for the economy of 1.3 percent. That number is very likely to be adjusted upward since several components, including construction spending, have already been revised to show somewhat stronger growth.
Still, personal income is showing strong growth, and the jobs market remains robust. Overall economic conditions simply do not explain the foreclosures and chilled out housing market. And interest rates by themselves would not always be a sufficient cause for loan default
The housing market, left to its own devices, would have topped out a few years ago, fallen off, stabilized, and then recovered in its usual cycle. This time, though, the housing boom was extended by the mortgage lending industry itself – aggravating the effect when the market eventually collapsed.
What we are now experiencing is the collapse of what resembled a Ponzi scheme in the sense that it needed uninterrupted rapid growth in order to sustain itself. When the growth slowed, the market collapsed, just like any other Ponzi operation.
A few years ago, as the traditional real estate market reached its peak, the housing boom was prolonged by expanding the market so that home buyers normally excluded from the housing market – because they did not meet credit, income or other lending standards – could now participate.
Lending to this expanded market became a mini-industry and was given its own name – “subprime lending.” Initially, most of this lending was what economists might call “market legitimate” in the sense that lenders were taking on known, additional risk and were being compensated in return, through higher fees and interest rates.
As the subprime market itself matured and became saturated, though, lenders seeking to continue the rapid growth they had enjoyed found they could do this only by ignoring prudence entirely. They began granting mortgages to anyone with a pulse who was willing to sign the loan papers. Almost effortlessly, sub-prime lending advanced from market legitimate to stupid.
There is little doubt that the growth and collapse of this market was a regulatory failure. Worse, it is a failure still not being addressed by the Bush administration or by Congress. In that sense, it is an unwelcome reminder of how well we dealt with the savings and loan mess.
Economists hope that the investor-led efforts to work out payments for delinquent mortgages can slow the forfeiture rates enough to let our robust and resilient market economy work its usual magic. It is just that, though, hope. Sometimes the dumb things we do end up causing a lot of hurt.
James McCusker is a Bothell economist, educator and consultant. He also writes “Business 101” monthly for the Snohomish County Business Journal.
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